A recent New York Times article highlights what it calls a “tidal wave of business bankruptcies” that are coming due to financial fallout from the COVID-19 pandemic. A number of high profile businesses have already declared bankruptcy, including J.C. Penney, Hertz, J. Crew, Neiman Marcus, 24-Hour Fitness, Borden Dairy, and Pier 1 Imports. More are sure to follow.
Typically, a business will file either Chapter 7 or Chapter 11 bankruptcy. A Chapter 7 bankruptcy liquidates all company assets in order to satisfy creditors and the business itself will no longer be operational. In general, benefit plans do not survive a Chapter 7 bankruptcy.
A Chapter 11 bankruptcy allows a business to reorganize until the protection of the U.S. Bankruptcy Code and it will continue to operate once it exits Chapter 11. Benefit plans may or may not be affected by a Chapter 11 filing.
Bankruptcy and Retirement Plans
Under the Employee Retirement Income Security Act of 1974 (ERISA), assets from qualified plans such as pension plans, profit sharing plans and 401(k)s must be kept separate from a company’s other assets. Therefore, these assets should be shielded from a company’s creditors, thus preserving participants’ rights to their vested retirement benefits.
Pension plans are protected by the Pension Benefit Guaranty Corporation (PBGC), which will assume responsibility for the plan in the event a company is unable to fund the plan or provide benefits to participants.
Businesses that file Chapter 11 bankruptcy may obtain relief from expenses related to retirement benefits plans by either reducing or suspending employer contributions, depending on the plan type and language.
Businesses that file Chapter 7 bankruptcy will typically terminate their benefit plans. To accomplish this, a company must:
- Amend its plan by adding the termination date and updating the plan for all necessary legal changes as well as any optional modifications;
- Communicate the plan termination to all participants and beneficiaries;
- Vest all affected plan participants 100%, including former employees;
- Distribute plan assets as quickly as possible after the plan terminates(typically within 12 months);
- File a determination letter request with the IRS to determine the qualification status of the plan at termination; and
- File applicable federal disclosures until distribution of plan assets has been completed.
